The Bill for Hidden Private Equity Fees: $4 Billion

As public pension plans in the U.S. increasingly invest in
private equity and other alternatives, funds may be paying more
than $4 billion annually in unreported fees, according to Pew Charitable Trusts.

The hidden costs of private equity investments  which
include carried interest, monitoring costs, and portfolio
company fees  were not reported as investment expenses
among most of the 73 large public funds Pew examined, according
to a report this week from the non-profit group. For example,
Pennsylvanias two public pension plans, the Public School
Employees Retirement System and the State Employees Retirement
System, dont disclose carried interest in their annual
reports.

Costs arent fully transparent because some plans
dont consider carried interest  the 20 percent
profit cut taken by private equity firms  as an
investment fee, according to the report. Another reason is that
opaque reporting by private equity managers leads
pension funds to view carried interest as a non-separable
expense that doesnt have to be reported as an investment
cost according to accounting standards.

These trends underscore the need for transparency on
plan performance and attention to the impact of investment fees
on plan health, said Greg Mennis, director of Pews
public retirement plans project, in a statement accompanying
the report.

The more than $4 billion in unreported investment fees,
primarily performance payments made to private equity managers
in 2014, is about 40 percent above the $10 billion in reported
investment expenses that year, the report shows.

Pennsylvanias Public School Employees Retirement
System and State Employees Retirement System, which manage a
combined $80 billion in pension assets, increased their
allocation to alternatives from 18 percent in 2006 to 49
percent of their portfolios in 2014, according to the report.
The shift drove reported their annual fees from alternative
investments to more than 0.8 percent of assets, already one of
the highest in the U.S., Pew said. When accounting for their
undisclosed carried interest for private equity, fees increase
to over 0.9 percent of assets, or more than $700 million
annually.

The average value of undisclosed private equity fees could
equal up to 1.5 percent of assets per year, Pew said, citing an
estimate from CEM Benchmarking, which provides analysis for
institutional investors. The report suggests pension funds
should consider whether returns from private equity and other
alternative investments will justify fees, as Pew found that
recent or rapid entries into alternatives had the weakest
10-year returns.

There are efforts underway to make fees more transparent.
The Institutional Limited Partners Association released a reporting template last year that would
establish standards for fee and expense reporting for
institutions and fund managers.

Several major funds have already adopted practices to
disclose fees, including the California Public Employees
Retirement System, which in 2015 said it would begin reporting total
carried interest paid to private equity. The Missouri State
Employees Retirement System reports fees by asset class
and for each external manager, a particularly thorough
practice, Pew noted in its report.

While plans vary widely in their investment choices within
the alternatives class, almost a third of the public pension
funds examined by Pew had more than 10 percent of assets in
private equity in 2014, while 15 percent had more than 10
percent in hedge funds. In 2014, CalPERS eliminated its $4
billion hedge fund investment program, citing high costs,
according to the report.

The data do not reveal a best or one-size-fits-all
approach to successful investing, but there is a uniform need
for full disclosure on investment performance and fees,
Pew said.

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